Euro Area Monetary Policy

At its 3 April meeting, the European Central Bank (ECB) kept the refinancing rate unchanged at the record low of 0.25% as the market had expected. The decision comes on the back of a broadly unchanged outlook for the Euro area economy. The ECB sees the economic recovery in the region moving ahead in the coming months, although risks remain on the downside; according to the ECB, “developments in global financial markets and in emerging market economies, as well as geopolitical risks”, may hinder growth in the coming months. Regarding the outlook for price developments, the ECB acknowledged that inflation will remain low over the course of 2014, “before gradually increasing during 2015 to reach levels closer to 2% towards the end of 2016”. That said, inflation expectations remain firmly anchored and risks to the inflation outlook are broadly in balance. In the statement accompanying the ECB's decision, President Mario Draghi reiterated the forward guidance adopted in the previous meeting, stating that the ECB continues, “to expect the key ECB interest rates to remain at present or lower levels for an extended period of time.” As in the previous month's statement, this expectation is not only based on developments regarding inflation but also on other points of reference (“broad-based weakness of the economy, the high degree of unutilised capacity and subdued money and credit creation”); this means that the ECB is taking the persistent slack in the economy into account in its decisions and that interest rates may stay low even when inflation returns at its target level of below, but close to, 2%. Additionally, the ECB stressed that, “[t]he Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.” While the last statement opens the door to non-orthodox measures in the future, it is unclear whether and when the ECB will actually decide to act. According to Richard Barwell, Senior European Economist at RBS: The key takeaway from the meeting is that the Council did not act in response to weak inflation and despite all the positive tone in the Introductory Statement and the press conference, it is not clear that the Council will act in the future given that inflation is expected to bounce higher and the recovery continues to gain momentum. According to Carsten Brzeski, Senior Economist at ING, ECB may be forced to keep up with its words: All in all, the bottom line of today's ECB meeting is that the famous “we stand ready to act” has been stretched to its maximum. No further verbal stepping up possible. The ECB seems to be well aware of the downside risks and implementation difficulties surrounding unconventional measures. Still, the ECB mentioned them to maintain its own credibility. [...] From here on, a further verbal stepping up seems impossible. In a way it's a gamble, either the recovery continues and inflation picks up again, or the ECB will have to act in June, even if it's only a small refi rate cut. Within this setting, analysts are still divided as to the course of action the ECB will likely take in the coming months. FocusEconomics panelists expect the policy rate to end 2014 at 0.22% and 2015 at 0.30%.